Numerous challenges have held back the medical device maker's earnings growth, causing Medtronic's forward P/E ratio to compress and trade at a discount to the broader healthcare sector's multiple.
The pandemic disrupted Medtronic's pattern of predictable growth as elective surgery postponements caused demand for many medtech products to plunge.
Procedure volumes returned to pre-Covid levels in 2022, but the swift rebound led to supply chain shortages that held back Medtronic's revenue growth and caused modest market share losses.
Inflation provided another headwind. Rising wages and higher costs of materials caused the company's gross margin to slip several percentage points below its pre-pandemic level near 70%.
Fortunately, these issues seem unlikely to impair Medtronic's long-term outlook and have started improving.
Medtronic's earnings report, released on November 21, showed that sales growth has firmly returned to management's mid-single-digit growth target. This success is partly attributed to new product launches, made possible by the company's annual investment of several billion dollars in research and development.
While these are positive trends, some Medtronic investors have started to worry about recently commercialized drugs that could reduce demand for certain medical products.
Breakthrough medicines Ozempic, Mounjaro, and Wegovy are used for treating diabetes and obesity. These drugs have generated significant consumer interest, as noted by The Wall Street Journal:
For years, researchers and drugmakers failed to find a drug that could help people cut pounds. After studies in recent months showed they safely worked, Mounjaro, Ozempic and Wegovy became social-media sensations and have emerged as widely used weight-loss treatments.
Investors have responded in part by selling off stocks tied to medical products. If excess weight causes many ailments, then fewer surgeries might be needed once more consumers are on therapies to manage their weight better.
Medtronic generates nearly 40% of its revenue from cardiovascular products such as pacemakers and stents, perhaps putting a bigger target on its back as weight loss puts less stress on cardiovascular systems.
The company also has some exposure to bariatric surgeries (a low single-digit percentage of revenue) used to manage obesity and a sizable diabetes division (7% of sales).
Outside of the small bariatric piece of the business, which has seen its rate of decline stabilize, Medtronic does not see these new drugs impacting its growth.
Management noted that the latest study of Novo Nordisks's obesity treatment Wegovy showed a lack of effect on cardiovascular death and that many patients who tried these medicines did not stay on them for more than a year due to side effects and affordability.
After updating its models, Medtronic continues to see "a negligible effect on the growth of cardiovascular procedure volumes" and the size of its addressable market over the next 10 to 30 years.
On the diabetes side, Medtronic primarily helps patients with Type 1, which these new medications do not treat. Only 10% of the firm's installed base of pumps is used by Type 2 insulin-dependent patients, so management does not "see any meaningful change in our diabetes growth outlook through 2030."
While the impact of new weight-loss and diabetes drugs needs to be watched, Medtronic's stock could prove to have been unfairly punished by this concern.
Even if demand for some cardiovascular procedures is reduced in the years ahead, Medtronic's diversification (products treat 70-plus health conditions), investment in innovation (R&D spending represents 8-9% of sales), and exposure to emerging markets (nearly 20% of sales) should help the company grow over the long run.
Coupled with an undemanding valuation, an A credit rating, and tailwinds from an aging population, Medtronic could appeal to long-term dividend growth investors who are willing to bet on the company's long track record of commercializing market-leading medical equipment and devices since its founding in 1949.
We will continue monitoring Medtronic's outlook, providing updates as needed. For now, we remain comfortable with the firm's Very Safe Dividend Safety Score and potential to accelerate its pace of dividend growth in the years ahead.